Period  2Q14/1H14

Actual vs. Expectations The reported 1H14 net profit of RM1,064.8m (+8% YoY) accounted for 52.7% of consensus estimate of RM2,021.0m and 51.8% of our forecast of RM2,054.1m.

Dividends  A 15 sen interim dividend was declared. This is in line with its historical trend. We expect the group to pay another 21sen gross dividend in the final quarter, raising the full-year DPS to 36 sen (≈1/3 payout ratio).

Key Result Highlights

1H14 vs. 1H13  In a nutshell, HLBANK’s 1H14 pre-tax profit and net profit grew 6.8% and 8.0% YoY, due to higher total income of 3.9% coupled with higher net write back of impairment losses from securities and higher share of profit from Bank of Chengdu and joint venture. However, this was blunted by higher allowance for impairment losses on loans.

 Net interest income grew 5.5% YoY despite gross loan increasing faster, by 8.2% due to further NIM compression of 9bps.

 While the loan growth was slightly below the management target of 10.0%, it was, however, higher than our estimate of 7.5%. The higher growth was mainly driven by stronger SME loan growth of 27.2% while individual/household loan grew at a slower pace of 7.5%. In terms of loan by economic purpose, the Bank seems focused on lending to non-residential properties, residential and construction sector, which grew 12.2%, 12.9% and 18.0% YoY, respectively.

 On the customer deposits front, while it only grew 1.7% YoY, which is way below the management target of high single-digit and our estimate of 5.0%, this is not a major concern to us. Firstly, the low cost deposits – CASA – grew at a much faster pace of 7.3% YoY and secondly, the loan-todeposit ratio (LDR) has improved from 75.1% as at end-Dec 12 to 79.9% as at end-Dec 13. Both scenarios have been able to improve NIM or to cushion contraction in NIM to a certain extend. The LDR remains supportive for growth.

 Islamic banking income dipped 4.2% YoY despite a marginal growth of 2.6% YoY in total financing. The decline was caused by the sharp contraction in profit rate of 31bps due to change in regulation in Islamic products.

 Non-interest income, on the other hand, grew marginally at 3.6% YoY and accounted for 26.7% of total income (in-line with the management target of 26%-29%). This segmental income growth was contributed by higher fee income and forex gains, which was partially offset by lower gains from sale of securities and mark-to-market.

 Operating expenses increased at a slower rate of 2.2% YoY, due to improvement in efficiency, which resulted in the cost-to-income ratio (CIR) improving slightly to 43.9% in 1H14 from 44.6% in 1H13.

 This quarter saw loan loss impairments of RM20.6m in contrast to RM18.0m writebacks/reversals in loans in 1Q14. Hence, a net RM2.6m impairment in 1H14 was seen as opposed to RM28.2m writebacks/reversals in loans in 1H13. The annualised credit charge ratio for 1H14 was recorded at 1bps. This credit cost is still below our expectation of 3bps. However, as the trend of normalisation in credit cost could have already started, we do not rule out further hike in our credit cost assumptions, if and when we see concrete signs of deterioration in asset quality.

 As for now, asset quality for the Banking Group remains solid. As of end-Dec 13, gross impaired loans ratio improved slightly to 1.33% from 1.49% in end-Dec 12. Loan loss coverage (LLC) of 127.5% was also amongst the highest in the industry with an industry average of 107% (vs. 139.2% in 1H13).

 Share of profits from associate & JV grew ~35.2% YoY. Bank of Chengdu (BOCD) remained the key contributor with profit contribution growing by 33.2% YoY and representing 12.6% of the Group’s PBT.

 Capital levels remain strong with Tier 1 and Total Capital ratios at 11.8% and 14.4%, respectively (vs. 12.6% and 16.3% in 1H13).

 The annualised ROE of 15.9% is ahead of our estimate of 15% and in-line with the management target of 15%-17%.

2Q14 vs.1Q14

 QoQ, net profit declined by 4.4% due mainly to RM20.6m impaired loan allowances in contrast to reversals / writebacks of loans and impairments of RM18.0m in 1Q14.

 Total income grew 2.5% QoQ mainly driven by non-interest income, which advanced 9.4% QoQ. Net interest income, however, declined marginally by 0.6% in-line with the 3bps contraction in NIM while gross loans grew 2.3% QoQ.

 While we saw higher operating expenses (+1.0% QoQ), CIR, however, was lower at 43.6% as opposed to 44.2% in 1Q14.

 However, this was netted off by lower share of profit from BOCD and joint venture (-17.1% QoQ).

Outlook  Our view remains unchanged. To recap, the management guidance and our major earnings model assumptions are per the following:

 Total loan growth: Management guided for ~10%. However, we only imputed 7.5% growth for the next two financial years.

 Customer deposit growth: High single-digit. As the LDR still remains supportive for growth, we believe the bank may not push for deposit growth in an aggressive manner; hence we only factor in 5% in deposit growth for the next two financial years.

 NIM: To sustain above 2%. We continue to maintain 2% NIM for the next two financial years.

 CIR: 42%-45%. However, we believe this may not be achievable in the short-term due to keener competition where we expect higher promotion and marketing expenses. Besides, we also believe other costs will remain sticky as well. Hence, we only factor in a gradual mild reduction in CIR (FY14: 45.8%, FY15: 45.2%).

 Credit charge ratio: 25-30 bps. Due to the continued improvement in gross impaired loan ratio, we believe the credit charge may continue to remain low, say <10bps, unless operating environment turns more volatile and challenging.

 ROE: 15%-17%. We believe this is achievable. In fact, we estimate ROE to register at 15.1% for the next two financial years.

 Net dividend payout ratio: Remains at 1/3. We maintain our NDPS forecasts at 36 sen and 39 sen for FY14 and FY15 respectively.

Change to Forecasts    We maintain our FY14E and FY15E net profit estimates of RM2,054.1m (+10.7% YoY)and RM2,253.1 (+9.7% YoY) for now.

Rating  Maintain MARKET PERFORM as the stock only offers < 10% upside from here based on our Target Price (TP).

Valuation  Maintain our TP of RM15.20, implying FY14E and FY15E BPS of 2.0x and 1.8x, respectively. At this TP, HLBANK is also valued at 13.9x and 12.7x on FY14 and FY15 PERs, respectively. While these valuations are not demanding, the stock could go through a de-rating process as its growth rates going forward have shown some sign of weakness.

Risks  Tighter lending rules and further margin squeeze in general.

 Tougher operating environment especially in treasury market.

 Higher-than-expected credit charge due to deterioration in asset quality.

Source: Kenanga